Redistribution Wall Street style

Everyone knows by the now that Bear Stearns the venerable, bulge bracket, but not white shoe Wall Street firm basically went under earlier this week.

For those who prefer a more redistribution leaning economic system you love this story. When Wall Street goes into redistribution/zero sum mode its the best well oiled machine bar none. In fact there isnt a government on the entire planet that can redistribute cash and other assorted goodies faster, cleaner and more painfully than Wall Street. The Bear Stearns fiasco is a perfect example.

About two weeks ago Bear Stearns was worth around US$ 75 bucks a share giving the firm a market cap of around $8.5 billion. Monday morning this week the firm had been sold for US$2 valuing the firm at just over US$230 million. What happened in between? Lots of things but by the far the worst were, unfocused and inept senior management, a gutless board and old timers who should never have been allowed to hang around forever and keep interfering. Hello John Howard meet Ace Greenberg and Jimmy Cayne (the two previous CEOs who never left).

Heres a trader’s perspective of this tragic soap opera …

A week before the Friday massacre, rumours began to circulate that the Bear was in trouble. Conspiracy theories (quite possibly accurate but perfectly legal) circulated that the rumours were started by one major hedge fund that was a large customer of Bear Stearns (as well as keeping most of its assets there for safekeeping). It withdrew its assets held in a custody relationship citing (and loudly circulating) concerns that Bear was in trouble and didnt like the credit risk. While doing this they began to short stock in Bear. Other firms began to withdraw their holdings too and a bear attack on Bear began.

Meanwhile the recently named chairman (and self demoted old CEO) was away playing in a bridge tournament leaving the new CEO alone to handle the mess. Confidence began to disappear rapidly and sure enough it became self-fulfilling despite appeals from Bears spokesmen throughout the week that things were fine and dandy. By Thursday evening it became evident that things were not that fine or dandy and the firm was no longer liquid so a call was put through to the Fed by the JP Morgan CEO.

The Fed gave the firm a secure credit line for 28 days, which actually turned out to be for 24 hours as Washington and the Fed basically told the firm that it had to be sold that weekend. The Fed never liked Bear Stearns, which goes back to the long-term capital fiasco. At the time, Bear alone out of all the big firms refused to participate in the LTCM bailout of the 90s. Its well understood that the Fed never forgets and always pays you back if one doesnt accept an invite to a Fed party. Bear refused to put in even $50 million to that bailout which would have placed it in the smallest donation group. The Fed really does have a long memory.

The stock closed at around 30 dollars on Friday afternoon and the firm was then sold for $2 by the end of the weekend.

Who was the happy recipient of all that newfound wealth? JP Morgan it seems is now the new the Fed (teacher’s) pet.

For a heavy weekends work (as someone mentioned at Catallaxy) JP Morgan got a business that will deliver $1 billion in profits annually, a building that is worth around $1.5 billion slap in the middle of mid town Manhattan that they can move into without even changing the curtains. Apparently the JPM guys have already started to move office or are about to do so. They also receive a Fed guarantee wrap around the Bear assets such as subprime. The entire cost was/is about $6 billion that includes a provision for the inevitable lawsuits that will arrive from really pissed off shareholders who rightfully think this was the biggest grand larceny of the past 100 years or so. Damn straight it was.

The eternally grateful but showy JP Morgan shareholders lifted the value of the firm’s stock by 10% the following Monday exhibiting all the bad traits by ill-mannered people that dont know how to behave at a wake.

So in a few days the Fed helped redistribute around $5 billion of wealth from one Manhattan office to another with all the finesse of an ax murderer.

Two billionaires are no longer billionaires. Jimmy Cayne the former CEO/bridge player is no longer in the extremely rich club and a long time Wall Street speculator – Irishman Joe Lewis – isnt either. Joe was taught about but forgot the lesson that you never, ever, ever, ever average losing trades as he was buying all the way down.

Moral of the story and possible point to include in a business school case study:

Get rid of dead wood as soon as possible in the upper ranks. Get them out of the building at all costs.

If the Fed invites you to a party you had better go and if asked be very generous with donations, especially to the Feds bailout club.

Dont ever think you have any friends on Wall Street that want to help you succeed or get out of trouble.

If you’re really, really in trouble, dont even think about going to the Fed and just file Chapter 11 or its equivalent as you end up getting better terms.

If you need a friend, buy a dog.

The tragic part is that lots of good people lost their jobs. And no, I dont mean just traders and investment bankers. Lots of administration and clerical staff are with a job in the biggest financial downturn in ages … About 12,000 of them in the end. This part is truly sad.

As an aside, recently quarter results from other investment banks reporting this week showed down but healthy profits and above market expectations. If only Bear had reported sooner.

We see here that its a totally corrupt system. And that this is inevitable when the norm is to run banks in a perpetual state of technical bankruptcy. And also to run a system which is in a perpetual state of teetering on implosion.

The whole system is ridiculous. A counterfeiting racket and a leach on the rest of the system rather than the efficient capital-allocation industry that it could be.

US financial stocks had a massive rally this week. Stocks like Morgan Stanely rallied 30%… 38 bucks low to a close of just under 50 bucks on Friday. Despite more writedowns they still produced a profit of around 20% on equity (return).

This is an extra-ordinary result depsite recession fears. Other firms also beat street estemiates this week.

The Troppopopolo have been generous in giving you a constructive angle to your blogging, JC. With that in mind would it be too much to ask for you to get an English-speaker to proof-read your post? First sentence in and you’d already fluffed it, FFS.

Also, you may want to update your post now that JPM has increased its bid to c.$10/share, though we’ve yet to see the Fed endorse it. Also-also, Lewis is English, not Irish.

2. I don’t need to update the revised bid as you already have, thanks.

3. Joe Lewis isn’t English. As far as I recall he’s an Irish Jew. He was a client of ours starting from the early 90’s. Don’t believe everythig you read in the papers.

4. No, not doing fractional, as it’s getting a little long in the tooth. However there’s a thread you could always participate.

The bid’s interesting. In fact it’s actually ingenious. JPM has essentially taken over the lease and ownership (of sorts) of Bear’s old building, so if the shareholders vote down the bid, Bear has nowhere to physically go. That also applies if a new player comes in and bids.

1. You want me to proof-read Homer? Why? Have you failed to express yourself clearly yet again? Are you getting the point yet? Bueller?
2. You’re most welcome.
3. Source, please.
4. Do you always respond to “Turkey”, JC? Interesting. It should be obvious I was addressing the sockpuppet “A J Nock”, better known by a multitude of more entertaining epithets.

Guilt perhaps… not wanting to make it look like it was grand theft….. perhaps the Fed told them it was a shockingly bad offer. Perhaps they figured out that it would have been cheaper raising the offer and reducing the number of lawsuits.

scuttlebutt says the firm is worth north of 7 bil. Could be much more if things stabilize and the credit markets actually turn around.

I know google and the papers have been saying he’s an eastender and all that, but I recall him saying he was Irish. He did lived in Ireland for a time until he moved down to Lyford Quay in the Bahamas for part of the year. Maybe he took out Irish citizenship for tax reasons? Dunno.

(I think) I also recall he made his first big bucks in the duty free business..

JC, you made it a bio on Lewis with your persistent bluster on the subject. And, again, no, he didn’t make his first “big bucks” in duty free; he made it in the catering business his father founded. If you had done some rudimentary research on the subject you’d know this.

You think the worst part of the squeeze in the US is over or not?

Depends on what you mean by “squeeze”. Credit market? Equity market? Economy?

Yes I checked the same google line you did and didn’t conform to what he told us one time. I really don’t think it’s the core part of the story, but if you think it’s important I want to thank you for raising it.

Depends on what you mean by squeeze. Credit market? Equity market? Economy?

Depends on what you mean by squeeze. Credit market? Equity market? Economy?

All three , thanks.

Well, as you asked so nicely…

Credit market – the toughest to call, IMO. The conjunction of extreme credit spreads and a steep yield curve has typically marked the low point in past credit cycles, and that’s why we’ve seen a turn in sentiment in the past week, after the latest Fed actions. Perversely, I also suspect the irrationally exuberant are taking the wrong messages from BSC’s collapse. That is, that the effective failure of one bulge-bracket firm is the worst that can happen, and that the rescue of its creditors shows the system can handle it. While I’m doubtful that spreads can go materially higher than the extremes we’ve just seen, I don’t think the “squeeze” is over: securitisation markets are still dead; deleveraging is still occurring (and feeding upon itself in hedgieland); banks have insufficient capital and funding to reintermediate effectively; and, worst of all, we’ve yet to see the full impact of the US recession.

Equity market – fuck no. The US equity market is not priced for a severe recession, which I think it’ll get. The non-financial sectors of the market are cum material downgrades and I expect the overall market to go lower.

Economy – likewise. The recession’s only just starting amidst a perfect storm of fubarity: the worst housing market since the Depression, the worst credit crunch in decades, high oil prices and an economy over-leveraged in every direction.

Great summmary, Fyds. Don’t know if anyone could add more to that. I think and hope the steepening yield curve is a reasonable indicator that the wrost part of the storm is behind us.

Don’t you think that the market has pretty much discounted the recession at this point. Average PE’s….. forward looking estimates don’t look exeedingly expensive and there is a lot of liquidity around on the side lines. I recall reading there’s about 3.5 trillion sitting on the side of the road.

I think and hope the steepening yield curve is a reasonable indicator that the wrost part of the storm is behind us.

As I noted, the steepening of the yield curve is traditionally a reasonable indicator that the credit cycle has bottomed. However, the yield curve can get steeper.

What we do know is that the steep yield curve is the direct result of the funds rate plummeting as Uncle Ben pushes the pedal to the floor in rather dramatic (if not downright panicky) fashion. The real interest rate is now negative, with a FFR of 2.25%. According to the traditional view of credit cycles this should jump-start the credit market. However, this cycle is unlike anything we have seen in the last few decades and thus the action to-date might not be enough. Maybe a 1% FFR will prove to mark the ultimate low; I don’t know. As I said, it’s a tough one to call.

Dont you think that the market has pretty much discounted the recession at this point. Average PEs.. forward looking estimates dont look exeedingly expensive and there is a lot of liquidity around on the side lines. I recall reading theres about 3.5 trillion sitting on the side of the road.

No. As I said, I think the non-financial sectors are cum downgrades – analyst expectations for earnings growth are far too high, IMO, given the recessionary outlook – thus forecast PERs are not reliable. Analysts are always over-optimistic heading into recessions; their earnings forecasts tend to be good lagging indicators of share prices.

On the issue of liquidity, I’m not as sure as you seem to be. The corollary of the credit market ructions we’re seeing is a draining of liquidity as leverage reduces in the system, and I doubt that leverage will return until we’re well into the upswing. I don’t buy the argument that there’s gorillions in cash waiting patiently on the sidelines of the equity market – investors aren’t that smart. Most of the cash hoarding we hear about is occuring in income funds, not equity funds, and for the obvious reasons. Consequently, when cash is released, it will go into the credit market first, before the equity market.

Moreover, liquidity in the equity market doesn’t seem to be a problem right now. In that respect, it doesn’t even “feel” like a bear market yet: sure, share prices have fallen and trading is highly volatile, but we haven’t seen the drying up of trading volumes that’s typical of a maturing bear market – that’s why you haven’t seen mass layoffs from stockbrokers yet. I think there’s worse to come.

How do you think things are working out here?

Better, because our economy has a much stronger starting point, in several different ways. The financial system doesn’t have as much crap in it, for a start. However, sentiment is king right now and it’s highly doubtful (IMO) that our equity market will turn before other, more dominant markets.

You know the thing that caught my eye was lasts week’s Morgan Stanley’s quarterly result. Despite the storm, despite new write offs they still managed a 20% return on equity (annualized) which was truly shocking from bearish point of view.

Still waiting to see what C comes up with. I think they report next month.

You have any views on the leveraged special vehicles here? Some such as MAP have or were beaten to a pulp.

However, this cycle is unlike anything we have seen in the last few decades and thus the action to-date might not be enough

Don’t you think this time around is a little similar to the early 90’s rout? That time it was commercial real estate that clobbered the banks along with some residential real estate. The S&L problem was about $250 bill. The last estimate I read was that the current mess is around slightly north of $500 bill. The economy was about $5 trill then and about $13.5 trill now. In the early 90s (or late 80s) Drexel turned off the lights and C was looking very shaky.

In fact C has been in the vortex of every major financial problem for the past 30 years. It was also heavily exposed to sovereign debt in the very early 80’s.

The credit markets are a once in a cycle opportunity as Jim Reid from Desustchebank in London has called it. the current spreads in world corporate bond markets read US imply that over 19% of five year investment grade bonds will default. The highest rate we have seen thus far is 2.4% in 1990/1 when companies in the US were overloaded with debt. They are at the complete opposite end of the spectrum at present.

Moreover once the market wakes up and matures they will plow money into solid investment grade bonds and even less.

furthermore Banks are at the we only want to loan to people/companies that don’t need loans’ at present. Just as in Australia in 1990/1 Banks will soon realise with a steep yield curve that it is only by lending they improve their books and corporate America will need loans.

Whilst the US bond markets have priced in a recession worse than 1974/5 the equity market hasn’t and I tend to think they are right. The transmission mechanisms aren’t there for a severe recession. Wages are okay, profitability is at a record as a % of GDP and so is debt servicing capability.

I would have thought a lot of CEOs would have been giving guidance to the market via lower earnings if the US was already in a recession.

I think the value is in the junkish US paper, though. I just checked some triple A’s. (US$ denominated) European Investment Bank is trading on a yield to maturity of 2.6% to 2011. JPM (single A) around the same maturity is trading at 3.9%. These aren’t very compelling yields so I think if the credit market stabilizes we could get an awfully big equity move in time. That’s where the big risk is. Not saying it’s going to happen but the risk of a large “melt up rally in US equities is starting to build perhaps.

I also think that people aren’t paying enough attention to the effect the fed rate cuts have had on US financials. Take Citigroup for instance. I would assume that C can maintain its asset side locked in at relatively high interest rate levels for a good while.

These Fed rate cuts have possibly added $20-30 billion in spread earnings for a while longer. People seem to ignore the effect the rate cuts have had on bank earning potential in the US.

Is it really Homer though? Obviously it’s someone wanting us to believe so. But that jibe the other day about Jason Soon learning English was quite nasty (not to mention racist), and that has never been Homer’s style at all. I can’t help wondering whether this is someone else entirely. However, since Homer is a pseudonym anyway, I guess we’ll just have to wait for a few really lame puns to before we can really tell.

As much as I think Homer deserves a decent throttle over the ears at times, i can honestly say that Hoems doesn’t have a racist or nasty bone in his body. I have never heard him utter any racist comment or said things to hurt or incite people that way.

Homer, if it is Homer would suggest ” learn English” to the queen.

Furthermore Jason knows homer and I wouldn’t think for a moment that jason would have taken it the way you’re suggesting.

Homer can say silly things but he would never ever utter a racist comment.
Homer’s just Homer. And by the way Homer really does exist. Shocked me too.

My working assumption is that it’s Homer (CL obsession, dopey pseudonym, idiosyncratic approach to punctuation, financial bent, long & wrong credit, awful puns, attempt to encourage JC into “nice” behaviour, fuckhowmanyboxescanItickonthisone, etc.) or someone trying very hard indeed to appear to be Homer. As it’s rather difficult to rationalise the motivation for the latter, Occam’s Phaser (set to “pun”) suggests it is, in fact, Homerkles.

If so, dude, please go back to “Homer Paxton”. Your latest nom de blog is truly ridiculous. By which I mean more than usually so.

King Tut is Homer too. If I thought it was anyone other than Homer I would have reacted differently to that comment about English but the fact is he’d said more or less the same thing to JC too in the past. Poor guy tries to remake himself but he just can’t help expressing the old Homey. Of course he has plausible deniability on his side

He suggests that it was the Fed that pushed JPM into offering a price as close as possible to zero for political reasons as Washington and the Fed wanted to show Main street that the government wasn’t trying to bail out Wall Street.

What’s even more intriguing is that The Fed announced the establishment of the investment bank facility the following Monday morning, a measure that would have possibly avoided Bear’s “bankruptcy”.

You can’t do that to us! In fact you have no right to just simply pull up stumps like that and say you’re only coming back in a few months. This isn’t a part time job, Homer. Your blog work-ethics suck.

Just enjoy the mess and see it as like something Italians would do if they were runnign a financail “empire”. It’s the best crater since 911. Just rubber neck and enjoy as this opera as they don’t come too often.

I think he’s answering to the accusation that he was King Tut on some other thread. Tut sounded awfully like the artist formally known as Homer Paxton and people legitimately pounced on the idea that Homer was Tut (or Tut was Homer… whatever).

(Amazingly there’s actually someone that sounds like Homer.)

IANCL is correcting the assertion that Tut isn’t homer and homer isn’t Tut although they sound remarkably similar.

What’s interesting is that Homes could have found his genetic twin right here on Troppo. That’s a first for any blog.

When I return to commenting I will have to think up another obvious moniker but I do not have to worry about that for a while and by the time that happens the credit crunch will be over and we can say we were there when the market lost its marbles.

How Norwegian bonds can ever have a default problem is beside me but then I would say the same thing about Aussie bonds.